Weekend Reading for Financial Planners (Mar 30-31)

Executive Summary

Enjoy the current installment of "weekend reading for financial planners" – this week’s issue starts off with an interesting discussion noting that the trend from regulators now appears to be allowing for and even encouraging the use of social media in financial services (albeit while still expecting firms to maintain proper procedures to oversee the activity), and a harsh look at whether our real problem in the financial services industry is not just the general lack of trust but the fact that the entire financial sector has bloated to the size that it has… and that even though the bloat stems largely from Wall Street, it’s those very firms that have such an integral role in rewriting the new rules for the future.

From there, we have a few industry and practice management articles, including a discussion of how marketing is shifting from just trying to convert a percentage of prospects into meetings and clients and instead towards engaging all prospects on an ongoing basis until they become clients, a look at Wealthfront and the rise of online investment providers, and a discussion of how you can break out of the rut of boring review meetings (which long-standing clients often resist) by structuring your reviews to have themes around broad financial planning topic areas that can be systematically revisited over time (yet provide more variety than just reviewing investments or asking if anything has changed).

In addition, there are a couple of technical articles this week, including a warning that health insurance premiums may be set to rise significantly with the new coverage laws taking effect in 2014 (especially for individuals getting coverage directly and some small businesses), a discussion of the unique planning challenges for families with special needs dependents (and the potential for advisors to create niche practices to serve them), a look at the so-called "dividend illusion" and that investors may be misunderstanding how dividends work if they think it’s a strategy to only spend income and not principal, and the latest Mauldin article dissecting the ongoing debacle in Cyprus.

We wrap up with three somewhat more offbeat articles: the first is looks at how color – the your clothing to the markers you use to illustrate key points – may influence your clients; the second is an excerpt of the latest Heath brothers book "Decisive" about how we can make better decisions; and the last is a somewhat controversial discussion from J.D. Roth, founder of the popular Get Rich Slowly blog, who observes that financial literacy alone just isn’t enough, primarily because most financial problems aren’t just about needing more information, but also about (fixing) our (dysfunctional) behaviors. Enjoy the reading!

(Editor’s Note: Want to see what I’m reading through the week that didn’t make the cut? Due to popular request, I’ve started a Tumblr page to highlight a longerlist of articles that I scan each week that might be of interest.You can follow the Tumblr page here.)

Weekend reading for March 30th/31st:

Regulators To Financial Services: Stop Fearing And Start Embracing Social Media! – In this article, social media consultant Augie Ray takes a broad look at how financial services firms – in the spirit of arguably prudent conservatism – have been dragging their feet on social media, but that change is imminent as the tide turns. In fact, regulators themselves have been shifting in their views regarding social media, following on the heels of new SEC new guidance on social media (discussed in last week’s Weekend Reading), which is generally being interpreted as a relaxation of the rules as the SEC went to great lengths to emphasize that not every tweet or Facebook post is automatically advertising that must be filed with regulators (as FINRA is being flooded with "advertising" to review and approve that isn’t really advertising, but just social media communication!). Similarly, the FFIEC (Federal Financial Institutions Examination Council, which is an interagency body that oversees a number of groups, including the Federal Reserve, FDIC, National Credit Union, and more) also issued proposed guidelines in January to make it easier for firms to engage in social media (and when finalized, the guidelines are expected to be pushed down to states as well), which went so far as to outright state that "social media may be used to market products and originate new accounts." While "perfect" guidance may never be forthcoming, Ray suggests that at this point the social media risks that are present are manageable with the guidance that now exists, especially given that so far no firm or person has been cited by a regulator for actions in social media, unless it was for actions that would have been cited in any other medium (e.g., pump-and-dump stock schemes). In other words, notwithstanding all the hand-wringing about social media guidance – or the lack thereof – the reality seems to simply be that as long as you don’t do anything in social media that you wouldn’t do in email, print, in person, or on the web either, there’s no reason to expect you’ll find yourself having run afoul of regulators, especially if you’re also using some of the social media compliance tools available to help manage the archiving, monitoring, and oversight! Ultimately, Ray suggests that the key for financial services using social media is support from leadership at the top of a firm, a balance between the business and reputation risks and the legal and compliance risks (especially as social media becomes not just about marketing but also servicing existing clients/consumers), and developing a broader marketing vision rather than solely obsessing over short-term ROI.

Parasites Who Would Be Fiduciaries – This article by industry commentator Bob Veres makes the interesting point that the ongoing debate regarding the fiduciary standard to protect consumers from some of the vices of Wall Street is really much broader than just the products and services we buy; in an environment where the financial services sector has exploded to 41% of the total economy – leaving all other industries in the aggregate, from aerospace and defense to manufacturing to pharmaceutical to energy to agriculture to housing to entertainment and more for "just" the other 59% – maybe it’s time to worry more about rebalancing the whole economy away from the financial sector and Wall Street in particular (which comprises the overwhelming majority of it). Veres notes the absurdity that now companies can’t raise money if they want to unless they pay Wall Street’s impliedly-usurious fees, and notes how distorted the system is when we consider an IPO like Facebook a "failure" because the stock was NOT underpriced enough for Wall Street to pass free profits out to its cronies and prospective customers! And that’s before the proprietary trading desks trading in front of clients – or outright making them the patsy – and the unimaginably large and opaque derivatives market. Of course, this doesn’t mean that the financial sector should be dismantled entirely – it is crucial to the effective functioning of our economy – but then again, that’s the point: for a sector so crucial to our economic system, why do we allow Wall Street to continue to function as it does, and is it time to bring back the walls within Wall Street firms to force the separation of brokerage, investment banking, deposit banks, and the delivery of advice, rather than allowing them a role in rewriting a fiduciary standard to fit their business model?

The New Paradigm Of Professional Services Marketing – This article by practice management consultant Tony Vidler makes the interesting point that financial advisors are undergoing a paradigm shift in marketing. The "old" world was the (in)famous 10-3-1 rule – if your marketing generates 10 leads, 3 will meet with you, and 1 will become a client. The more prospects the reach, the more 10s turn into 3s which turn into 1s, and it was just accepted that failing to do business with 90% of the prospects your marketing reached was the cost of marketing. In today’s world, the picture is changing, and virtually anyone can eventually become a client, as long as we continue to keep them engaged until they’re ready to work with us. Thus, with the growth of social media as drip marketing, and technology to manage the information and maintain ongoing engagement we’re going from "how can we get more prospects from our marketing" to push through the 10-3-1 funnel to "how will we engage with everyone effectively and meaningfully until they are ready to become our [clients]" instead.

Wealthfront And The Rise Of The Machines – On the IN Tech blog, Davis Janowski takes an interesting look at Wealthfront, one of the technology start-up firms that is aiming to go direct to consumers as competition to advisors, and just raised $20 million in a new round of venture capital funding, feeding off the recently reported trend from Cerulli that more investors are using the direct retail channel (although if you look at the underlying data, it’s at the expense of traditional brokers, not the independent channels). Wealthfront is classified in more of a delegator category than a do-it-yourself platform, as investors get diversified portfolios of low-cost ETFs designed and implemented by Wealthfront on their behalf. While the momentum has been limited so far – Wealthfront has raised $170M, which is no small amount, but not exactly huge when it’s charging just 25bps and is trying to justify a $25M investment – its being backed by some big venture firms, including Reid Hoffman of Greylock Partners who was previously a co-founder of LinkedIn. Because Wealthfront is a technology firm first, though, much of its focus is on its software, with sophisticated algorithms for investing and now tax-loss harvesting, and a nearly continuous series of software updates to their web-based platform. Worth reading as well are the article comments (including some from yours-truly) that provide additional color commentary. The bottom line is that it’s not necessarily clear if Wealthfront is really going to be an adivsor threat, but Janowski emphasizes that advisors need to be aware of their computerized competition, as it is improving at a rapid rate and not likely to plateau anytime soon. Or viewed another way, "Once the limited numbers of high-net-worth clients are spoken for by your human competitors, and the mass affluent and mass market are spoken for by the machines, who will be left for you?"

Themed Review Meetings – This article by advisor coaches Stephen Boswell and Kevin Nichols on Wealth Management looks at the challenge of getting clients to come in for review meetings; while the affluent might still prefer face-to-face meetings over other communication options, that doesn’t answer the question of how to frame meetings that will be compelling enough for clients to want to show up in the first place! The problem is that many advisors fall into a routine of conducting the same kind of review meeting over and over, boring their clients (and perhaps themselves!?) and making the meeting itself unappealing (not to mention dragging down any interest in making referrals!). So what’s the alternative? Build a calendar of recurring financial planning issues that are relevant for clients, and build themed meetings around those topic areas. For instance, the first review each year might be a "Portfolio Review" focusing on asset allocation, performance, and fees, but the second would be a "Financial Planning" meeting focused on updating net worth statements and retirement projections, and the third might be a "Risk Audit" meeting that reviews Wills, Estate Planning, Insurance, etc. Many financial planners will likely say that they routinely cover all of this anyway, but the point here is not just to respond to it reactively when a client asks about any of these areas, but to proactively frame the meeting around these issues for clients in the first place, which can both provide better structure to the planner’s process and also make review meetings more compelling for clients than just being asked "So, is there anything new in your financial life that I should be aware of?"

Health Insurers Warn On Premiums – From the Wall Street Journal, this article explores the outlook for health insurance premiums in 2014 with the coming of the new state health insurance exchanges and the mandatory coverage requirements for all Americans. The early word from health insurers so far is that they’re very concerned about potential claims with the transition – which is translating into a potential leap in premiums, where rates might even double in some areas, in stark contrast to the original expectations for the legislation that the average individual premium would be lower once the new law was fully implemented. Premiums are also being impacted by the fact that the required coverage levels are higher than the coverage many insurers currently offer, yet the companies will be prohibited from setting premiums based on health of the insured, and will even be limited in age-based pricing. The biggest brunt is expected to be on individuals buying their own plans, where UnitedHealth indicated costs could rise as much as 116% at the extreme and Aetna reported 55% on average, whereas small business rates might rise "only" 25% to 50%, and costs are actually expected to be the most stable for very large companies. Notably, the reality is that many consumers won’t pay that full cost, due to the government subsidies that cap the amount of premiums many will have to pay (for individuals with income up to $45,960 and families of 4 with income up to $94,200), but those subsidy costs in turn will revert back to the Federal government to the extent that current tax revenues do not cover the subsidies necessary if costs turn out to be higher than anticipated. In addition, if premiums are much higher than expected, companies may find themselves forced to pay more for their employees, or face the new government penalties for failing to sufficiently subsidize employee coverage. The bottom line – stay tuned for health insurance premium volatility heading into 2014, and stay tuned for more information as the dust settles in the coming months and insurers begin to submit their final new premium rates to regulators for approval.

The Team Approach To Financial Planning For Families With Special-Needs Dependents – From the Journal of Financial Planning, Professors Mitzi Lauderdale and Sandra Huston of Texas Tech University look at some of the unique challenges in serving clients with special-needs dependents, in terms of not only the technical planning issues involved from financial to legal matters, but also and perhaps especially the psychological and social complications. Major issues include family concerns as the family is squeezed by all the pressures, quality of life, financial security for special-needs dependents, balancing work-life conflicts with such a complex family environment and the need for appointments with care specialists, and the availability of resources (or lack thereof) to provide for special-needs dependents (especially after the parents are gone); given all these complications, the divorce rate for parents of special-needs children is estimated to be as high as 90% (and of course, divorce only complicates the planning further!). Although many of the core technical areas are the same – risk management, investments and cash flow, taxes, and legal matters – the tools vary in the special needs situation, especially regarding the use of a Special [or Supplemental] Needs Trust (SNT) to provide financial assistance to beneficiaries without disqualifying government aid, and crafting a letter of intent that stipulates how care is intended to be provided (especially after parents are no longer able to provide the care themselves). Perhaps most notable, though, is simply that because of the depth and complexity of these issues, planners who don’t specialize in special-needs families may often feel overwhelmed in working with them; as a result, there are a shortage of planners able to help such clients, or viewed alternatively a significant opportunity for some advisors to take this on as a specialized niche. In addition, the article notes that even as a specialist, the demands of a special needs situation may span the capacity of one advisor; as a result, a team-based approach is strongly recommended, incorporating an attorney, accountant, trust officer, insurance specialist, and others as necessary.

The Dividend Income Illusion – This article on the blog of Larry Frank provides some interesting thoughts about the caveats and problems of clients who are too dividend-centric in their investing. The primary issue is the so-called "dividend income illusion" – the fact that as dividends are paid, stock prices adjust downwards for the payment of the dividend, which means you’re really not "saving the principle and spending the income" but actually just spending pieces of the principal as they’re force-distributed to the investor! However, since most dividends are fairly modest relative to the magnitude of even daily market volatility, investors rarely notice this phenomenon – thus the "illusion" of it. In addition, the problem with dividend-centric investing is that dividends are paid far more in some industries than others, which means focusing too much on dividends ends out reducing the diversification of the portfolio (as investors in high-dividend-paying financial stocks sadly discovered in 2008!). The bottom line: dividend only is actually a principal-spending strategy, and one that can leave the client less diversified, so Frank advocates a total return approach instead.

You Can’t Be Serious – In his weekly article reproduced on Advisor Perspectives, John Mauldin discusses the surprises that happened in Cyprus – not the fact that the system was overleveraged, that the country could default, or that the banks could be in danger, but that apparently European leaders were somehow themselves surprised and caught off guard when it happened… and it seems so were the Russian investors who had left their money in the Cypriot banks. As a result of this unpreparedness, the initial European response was to haircut all depositors – despite an implicit 100,000 Euro guarantee that was widely believed to be sacred – which went nowhere as the plan was unanimously rejected by the Cypriot parliament… no surprise, given that nearly 97% of all depositors (most of whom are voters!) had account balances below this threshold. The revised plan protects all the smaller depositors and shifts the burden to larger deposits – many of which are believed to be foreign (Russian) or being sheltered as a tax haven in Cyprus – with an uncertain haircut estimated to be anywhere from 15% to as much as 40%. The real complication, though, is that to prevent a flight of money from Cyprus that would exacerbate the problem further, the European leaders are suggesting that capital controls may be necessary – which may drag out for an indeterminate amount of time as the politicians try to sort out just how much of a haircut is necessary – and these capital restrictions drastically undermine the entire principle of the Eurozone as a monetary union where money can flow freely. Mauldin suggests that this may lead to very problematic unintended consequences, such as corporations that become fearful to leave any money in banks (even just to facilitate payroll!) when it can be lost in this manner, not to mention the fear for wealthy investors, as European companies and citizens begin to fear whether a similar problem could occur in their own country, especially in those countries that have banking systems too large to bail out and therefore could be forced to "bail in" large depositors instead. And given the need for banks to maintain capital under Basel III, it may be impossible to keep the banking system sufficiently capitalized without large (uninsured) depositors. The bottom line: Europe has created a very inhospitable environment for depositors, at the exact time their system depends the most on depositors, and it’s somewhat astonishing that it’s all been triggered over a $5.8B Euro shortfall in the Cypriot banking system after the Eurozone leaders previously came to the table for trillions in other recent crises!

How Colors Affect Your Investment Decisions – This article takes a look at the how color impacts our perceptions, as what our eyes perceive impacts our subconscious decision-making process even though we’re often unaware of the effect. And in a business where conveying trust, commitment, and richness are key, it’s crucial that your colors match your messaging. So what colors should you focus on? Royal blue suggests security and trust, and green is typically associated with wealth. by contrast, yellow sends a sign of caution, and red an outright warning. Large companies already recognize this – it’s no coincidence that Fidelity and TD Ameritrade flash green, Vanguard communicates in red (to communicate the warning about high cost that they’re trying to bring you), while Ameriprise relies on blue to convey the trustworthiness of their advisors. It may sound silly, but the author acknowledges that in his work as an advisor, color was relevant in everything from what he wore (a yellow versus royal blue tie) to what markers were used to illustrate concepts (use red markers to illustrate things to avoid, and blue/green markers to illustrate things that are good!).

Decisive – This article from the Stanford Social Innovation Review is an excerpt from "Decisive: How To Make Better Choices In Life And Work" the new book by Chip and Dan Heath (authors of the also popular books "Made To Stick: Why Some Ideas Survive and Others Die" and "Switch: How To Change Things When Change Is Hard"). The discussion starts out with a sample scenario of a consulting firm trying to decide whether or not to fire an employee, and the Heath brothers note that within just a few seconds of reading the story, our brains are already forming opinions of the people involved, and coming to a conclusion – whatever the conclusion, it’s notable that we almost always come to SOME conclusion, often quickly, and are rarely stumped or flummoxed. The problem, however, is that we often come to those decisions because of the shortcuts our brains take; as a result, while we’re often quick to be decisive, and it’s often not for rational reasons, as we overemphasize whatever limited information we have available (called the "spotlight effect" because we tend to only focus on the information in the spotlight). In fact, the article notes our impressively poor track record for decisions, from the high number of lawyers who don’t recommend young people go into law, to the turnover of executive searches, to the high quit rate for teachers, and the results aren’t much better if we look at the track record for businesses. The trend continues for individuals, whether it’s failing to save enough for retirement, or making bad investment decisions with the savings we do have. So how do we improve the situation? It’s not to rely on our gut feelings, which are remarkably inconsistent. Instead, we have to force ourselves to look at the issue from more angles, and then we can begin to see past the spotlight and get a different, better-rounded perspective. But as it turns out, just trying to gather information and analyzing it is not enough, nor is making a Pros and Cons list that may be hopelessly biased by our own perspectives; the real differentiator is not just getting the data, but the process by which decisions are made with the data, especially the extent to which alternative views and an outright search for contrary evidence are incorporated into the process. In fact, one research study found that "process mattered more than analysis–by a factor of six." Interesting implications for the financial planning decision-making process, to say the least!

Why Financial Literacy Fails – This article takes an interesting look at some of the behavioral aspects that challenge consumers struggling with financial literacy – written by J.D. Roth, founder of one of the most popular personal finance blogs Get Rich Slowly, who has spent a great deal of time trying to support financial literacy himself. Roth starts out by making the point that the most basic aspect of financial success is pretty simple – spend less than you earn – but that most people struggle with it, even if they did have "financial literacy" classes when they were young that taught how checking accounts work and how to prepare a budget, because of their own behaviors. In other words, "money is more about the mind than it is about math." Roth suggests this is exacerbated by two fundamental factors in today’s environment – we are constantly bathed in media and subjected to (and influenced by) the power of marketing, and we spend too much on impulse out of habit (and in fact are often encouraged by marketing to do so!). As a result, Roth suggests that ultimately we need to spend less time teaching financial literacy information; don’t focus on financial mechanics and facts and figures, and instead spend more time teaching goal setting, how to break free from marketing messages, and behavioral finance techniques.